The food industry is caught up in a promotional trap, says Kraft CEO: ‘All of us have to realize it’s not the long-term way to run a business’

Tony Vernon: 'In some ways, we have to unlearn what we believed to work in the past'

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Tony Vernon, Kraft Foods Group

Trade spending is not delivering in the way that it used to, and if the food industry wants to deliver profitable growth, it needs to reallocate resources into bigger and better innovations and brand-building - which “requires discipline”, says Kraft Foods Group boss Tony Vernon.

Speaking to analysts on the firm’s second quarter earnings call yesterday, Vernon said: “Right now, industry returns on promotional activities, innovation, and even product renovation are lower than what we’ve seen in the past.

“As an industry, top line growth and more specifically profitable top line growth has been and is likely to remain challenging in the near-term.”

We fell into a promotional trap that’s bitten many in our industry

The latest quarter had been unusually challenging as Kraft had raised prices on half of its products in order to reflect rising commodity costs - but at the same time had got caught in an intense bout of promotional activity in a quarter that included three holiday periods: late Easter, Memorial Day and July 4, added chief financial officer Teri List-Stoll.

“In a couple of our businesses, meals and desserts and parts of beverages, we relied more on promotional and coupon activity in the second quarter that we’d want to, a promotional trap that’s bitten many in our industry.

“In this environment, it is easy to fall prey to price discounting as a way to sell a temporary short fall in gross revenue or volume and to look to get a short-term boost in productivity from the volume leverage that occurs in the plan. But these activities can hold us back.”

In the first half of 2014, of the largest 100 food and beverage categories, which represent over 80% of total food and beverage, nearly two-thirds increased the percentage of dollar sales derived from promotions, noted Vernon.

“Yet, the promotional efficiency to drive incremental sales did not hold pace with only 45% of these categories.”

Returns on promotional activities, innovation, and even product renovation are lower than they used to be

Despite the pressure to turn on the trade spending nozzle to meet quarterly targets and retain market share, he said, “I think all of us have to realize that it’s not the long-term way to run a business. A long-term way is to innovate and offer a real value to a consumer and that’s where we got to go.”

Meanwhile, bosses needed to keep a closer eye on online trade spending, he added: “Themost important dynamic in couponing today is the stacking that’s going on enabled by the internet. And really all of us are working through what is an incredible change and how consumers are able to process the coupon and stack them up … and if we’re not careful the consumer is getting a discount that’s more than they need.”

It’s not the long-term way to run a business

As for innovation, he said, as many market researchers have recently observed, smaller, more agile players seem to be better at it than many larger companies.

“The smaller players who are innovating quickly and frankly quite well are getting a receptive audience in our retailers because of the need for innovation.

“In light of these trends, we’re going back and taking a harder look at some of our smaller innovations, smaller SKUs, and marginal marketing programs to decide where we continue to fish and where we need to cut bait, and make sure we are living the principal of fewer, bigger, better.”

Meanwhile, despite the pressure as a public company to deliver every quarter, he said, equity building programs such as advertising, meaningful innovation and brand renovation, take time to deliver, as does building distribution in non-traditional channels. “It all requires discipline and we need to stay sharp on this point.”

We have to unlearn what we believed to work in the past

He added: “In some ways, we have to unlearn what we believed to work in the past and relearn what will make a difference today. In the short-term, adjusting to such momentous shifts favors the smaller, more nimble players that are working from a small base. And I think that's what you're seeing to play out in the most recent set of financial results across the food and beverage industry.

“However, our breadth of expertise shared insights and our scale is what will help Kraft win together.”

He then went on to outline some recent success stories, from the growth of A1 original sauce - which is starting to attract a new, younger customer base thanks to a “well integrated social media and traditional marketing campaign”; and the strong performance of Philadelphia cream cheese following a brand refresh.

“Brand renovations are a must if we were to keep our brands relevant," said Vernon. "It is and will be one of our biggest areas for investment. Innovation overall continues to be critical to keeping our brands relevant and we continue to be very excited about the success of our Gevalia brand, P3, as well as Lunchables uploaded and Kabobbles."

Q2 highlights

Kraft's Q2 earnings plunged 42% to $482m vs the same quarter a year ago, while revenues rose 0.7% to $4.75bn (analysts expected $4.88bn).

In cheese, net revenues rose 1.6% to $952m due to price rises in response to record-high dairy costs, but volumes were lower. In refrigerated meals, net revenues rose 2.6% to $916m driven by price rises, the introduction of P3Portable Protein Packs, and continued momentum in Lunchables.

In beverages, net revenues were flat at $748m as volume gains driven by coffee and Capri Sun were offset by lower pricing caused by an increase in promotional spending.

In meals & desserts, net revenues were down 5% to $518m primarily driven by continued weakness in Jell-O and lower pricing due to increased promotional activity behind Kraft and Velveeta dinners.

Finally, in enhancers and snack nuts, revenues rose 1.4% to $600m reflecting the benefit of the Easter shift as well as continued growth in Planters snack nuts.

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Trade spending is not delivering in the way that it used to, and if the food industry wants to deliver profitable growth, it needs to reallocate resources into bigger and better innovations and brand-building - which “requires discipline”, says Kraft Foods Group boss Tony Vernon.